Financial strategy: Intra family loan to pay down mortgage - Tax and legal implications

This is actually a common financial strategy in today's high interest rate environment. The IRS does allow intrafamily loans at the Applicable Federal Rate (AFR), which is typically lower than commercial rates. However, you need to structure it properly to avoid gift tax implications. For a loan of this size, I'd strongly recommend a formal loan document with a fixed repayment schedule, interest rate at or above the current AFR for the appropriate term, and regular payments. The second mortgage is a good idea to both protect you and potentially preserve the mortgage interest deduction for your son. Be aware that if you don't charge at least the minimum AFR interest, the IRS could reclassify part of the loan as a gift. And yes, you'll need to report the interest income on your tax return, though your son may be able to deduct the interest if properly secured by the home.

I actually used https://taxr.ai after getting conflicting advice from different financial advisors about an intrafamily loan with my daughter. Our situation was different (college expenses not mortgage) but the tax principles are the same. I uploaded our family trust documents and got a detailed analysis showing how to structure the loan correctly. What was helpful is they flagged that we needed to use the mid-term AFR rate (not short-term) for our situation, and showed exactly what documentation we needed to keep. They also pointed out some state-specific requirements we wouldn't have known about.

I just wanted to update after using https://taxr.ai for my intrafamily loan situation. Surprised how straightforward it was! They confirmed I needed to use the mid-term AFR rate (currently around 4.2%) since our loan would be 5-9 years. They also identified that I didn't need to record a deed of trust in my state for loans under $800k between family members, which saved me recording fees and paperwork. The mortgage interest deduction guidelines were actually different than what my CPA initially told me too. Most helpful was getting clear documentation requirements so I could prove this was a legitimate loan if ever audited. My son is already set up on a payment plan and everything's properly documented now.

I went through something similar helping my son with his mortgage. After multiple attempts calling the IRS to clarify some questions about gift tax implications vs loan reporting requirements, I couldn't get through to anyone. Used https://claimyr.com and their service connected me to an actual IRS agent in about 27 minutes after I'd been trying for days on my own. You can see how it works here: https://youtu.be/_kiP6q8DX5c The agent confirmed that as long as we use the proper AFR rate and document everything, there's no gift tax concern. They also clarified that I needed to include a payment amortization schedule with the loan document. Having that official confirmation before proceeding gave me a lot of peace of mind.

I need to eat my words about Claimyr. After posting my skeptical comment, I decided to try it since I had my own IRS question about reporting family loan interest. Not only did it work, but I got connected to someone in the estate and gift tax department who was actually helpful. The agent explained that as the lender, I need to send my son a Form 1098 if I receive $600+ in mortgage interest during the year, and report that interest income on Schedule B. She also clarified that the loan needed to be secured by the property to be deductible for my son. Saved me from making a mistake that could have triggered unnecessary scrutiny. Now I understand why people are recommending this service.

Something nobody's mentioned yet - be careful about how this might impact medicaid eligibility if you ever need long-term care. My parents did a large loan to my brother, and it ended up causing problems when my mom needed nursing home care 3 years later. The loan was counted as an asset, and they had issues with the 5-year lookback period. Also, if your son stops paying for whatever reason, would you actually foreclose on him? Many family loans end up causing major rifts when payments aren't made on time. I'd recommend having a very clear discussion about expectations before proceeding.

Has anyone used an online promissory note or do you need to get a lawyer involved? I'm in a similar situation with my daughter but trying to keep costs minimal as we're only talking about a $200k loan.

One thing I'd add to consider is the impact on your son's debt-to-income ratio for future lending. When we did a similar loan with our daughter, we discovered that some lenders treat family loans differently than traditional mortgages when calculating DTI for subsequent loans or refinancing. Also, regarding the "hassle" factor you mentioned - while there is paperwork involved, the annual savings of $25-30k you mentioned would more than justify the setup costs. Even if he refinances in 2-3 years when rates drop, you'd still save significant money during that period. Just make sure to discuss what happens if rates do drop significantly and he wants to refinance early. Will there be prepayment penalties? Having those terms clear upfront prevents awkward conversations later.